Capitalism Is Not “Doomed”

One of The Economist‘s weekly cartoons showed a bazaar full of T-shirts, mugs, and banners emblazoned with the slogan “Capitalism Is Dead!” A stockbroker surveys the many customers buying this sentiment in its many forms and remarks, “I think I’ve found a growth market!”

That was in October of 2008. But recent volatility in the financial markets seems to have a renewed an appetite for the idea. So Nouriel Roubini’s recent op-ed, “Is Capitalism Doomed?” isn’t as late to the market as it first appears.

The question of capitalism’s demise may be arresting, but it’s not helpful, in part because if the answer were “yes” no one would know what to say. What would replace it? “Capitalism is dead, yes, and the future is all about populism/mercantilism/barter/Linden Dollars/computer-optimized central planning?” Maybe not.

Comments like Roubini’s (and, for the record, we subscribe to the policy prescription he outlines in that post) imply that capitalism is some fixed set of rules and precepts that, never changing, will either work or collectively collapse. And the rules that Roubini and others identify did work brilliantly for a long time. They fear that the upheaval of the past few years will explode this stable — or frozen — way of doing the world’s business.

Here’s a different — and we think more useful — point of view: “How will capitalism evolve in its new environment?”

What happens when we think about capitalism as a system, a set of rules that govern the behavior of decision makers, individual or institutional? When rules work well, they become widely distributed; when they are harmful, they leave the system. For example, the rules governing limited liability corporations worked well to provide the capital needed for the industrial revolution with its large scale financing requirements, so debtors prisons died off. It’s a mirror of biological selection, in which, for example, the gene for sickle cell anemia is present in populations where malaria is common, but dies out in cooler, drier climates.

Globalization has spread the rules of what we might call “advanced economy capitalism” (that Roubini & co. identify with) to places to which they are poorly adapted. Capitalism’s home has moved from high-income, low-growth, aging societies where capital is so abundant banks use it to play games to the reverse: emerging markets with youthful populations, rapid growth, and low incomes, which need to invest capital in human and physical infrastructure. Societies with urgent agendas and abundant opportunities to improve the health, education, and welfare of their citizens will resist handing control of their economies to forces whose only interest is financial gain. So capitalism is bound to change.

An example of this shift occurred in the late 1990s, during the “Asian Contagion” of currency collapses, when Mahathir bin Muhammed, Prime Minister of Malaysia, suspended the conversion of the Malay currency. The IMF and other financial players were incensed at this crime against capitalism, because Malaysia closed their favorite blackjack game — the one where they both placed the bets and dealt the cards by selling so much of a currency that they ensured the collapse, almost risk-free. Mahathir stood his ground, preferring to protect the economic health of his country to defending principles of free trade at enormous civil cost. Two years later, as Malaysia boomed, the IMF apologized for criticizing Mahathir. Mahathir replaced one of the rules of advanced capitalism — prioritize the financial players over the population — with an alternative. As power flows from G7 countries to more Malay-minded countries, the mutation could become the norm.

So the question becomes not whether capitalism is doomed, but rather how it will evolve away from its current form toward one more fit for a global economy. Reform of the financial industry is a necessary step because, in Roubini’s terms the “financial system run amok” is at the root of the problem and financial institutions and even regulators are not incented to fix it. Europe should continue pressing its banks to participate in writing down sovereign debt, as the US should push its banks to write down mortgages. But most importantly, the financial industry must not be allowed to inhibit the evolution of capitalism. As it moves from the swamp, the sickle cell anemia gene does more harm than good.